Yahoo!'s Unlikely Candidate For Sugar Daddy

BURLINGAME, CALIF. -Yahoo! needs a sugar daddy--could it be tired old AOL?

This weekend, word leaked that Yahoo! was planning to send Microsoft a "Dear John" letter on Monday formally rejecting the software giant's offer of $31 a share as too cheap.

Chief Executive Jerry Yang wants to keep Yahoo! independent and has spurned approaches in the past. But Yahoo! is in play now and clearly needs a partner. According to The Times newspaper of London, Yahoo! is exploring a deal with AOL, the beleaguered Internet division of Time Warner.

Perhaps it's a strategy aimed simply at driving up readership on Yahoo!'s news channels. Yahoo!'s twists and turns are becoming the financial version of a soap opera.

Last week, Time Warner's new chief executive, Jeffrey L. Bewkes, said he planned to split off AOL's Internet access operations from its Web site and online advertising business. The Internet access business is profitable--but shrinking. Overall, operating income for AOL for the past quarter (excluding one-time events) was essentially flat. That would hardly suggest that AOL's Web business is a money machine.

Although both Yahoo! and AOL command healthy Web traffic, both have had a hard time turning those eyeballs into profits. Combining any portion of AOL with Yahoo! might be a great deal for Time Warner, but it's hard to see how it helps Yahoo!

Pundits may spin out stories of how the two will together have a hefty chunk of e-mail and Internet messaging, but neither of those businesses pulls in anything like the riches of search advertising.

Meanwhile, in Silicon Valley, the first wave of Yahoo! employees will get pink slips this week. Those job cuts--about 1,000 in all--were first mentioned when Yang released the company's fourth-quarter results in late January and predicted slower growth ahead. More layoffs are likely in the future, particularly if Yahoo! continues to flirt with alliances with businesses that have had an even tougher time making ends meet than it has.

A Yahoo-AOL alliance makes sense for only one organization: Google. It leaves Google free to dominate keyword search, with only a few stray ghosts of competitors to keep away the anti-trust regulators. It won't matter whether Google's search engine is significantly better than competitors. Advertisers will continue to flock to it because of its towering presence.

Right now, casual searchers won't see tremendous differences in the results offered by Google, Yahoo! and Microsoft's search engines. For instance, plug "ski in Tahoe" into those three search engines and the results are mighty similar. The first result to pop up at the top for all three is identical: "skilaketahoe.com." Of the 10 search results offered by each site, seven to eight of those listings show up on at least two of the other search sites. Google could boast three "unique" results, but two are for specific resorts. Both Microsoft and Yahoo! dug up unique directories of Tahoe skiing linked to a wide array of services.

Google did a fine job of pulling up relevant ads: it lists eight ads for travel agencies and booking services to help you go skiing. Microsoft's search results include a handy snow report--but among its eight ads is one for a Chevy Tahoe truck (no thanks) and a generic ad for Yahoo! Travel. Yahoo! should take the prize for putting up the most ads: it offered a full, relevant dozen.

But who's to know? In December, Google carried out 66% of U.S.-based Internet searches; Yahoo captured 21% and Microsoft did a bit more than 5%, according to market analysis firm Hitwise. (See: "Climbing The Ad Web Landscape") Familiarity breeds steady habits: Why, with results that are so similar, would anyone switch to a different search engine?

Microsoft Chief Executive Steve Ballmer said as much to The Wall Street Journal.

"The reason why Google is a market leader is not because they have [more] products," Ballmer said. "They're the leader because they're the leader in one product area, called search."

Yahoo! still commands tremendous Web traffic--just not the sort of traffic that pays the bills.

It has a hidden strength in display advertising: According to comScore, Yahoo! accounted for close to 19% of all the display advertising seen by U.S. users in November, followed by Microsoft at 6.7% and then Google at 1%.

Some Internet pundits contend that display advertising will eventually become more valuable than keyword search. Keyword advertising assumes that consumers are only searching the Internet to buy a product. As consumers grow more comfortable using the Internet to provide news and general information, an elite category of "brand building" advertising will arise, just as it has on television and in glossy magazines. By that logic, Yahoo! could have valuable properties--but it will take time.

Would a deal with AOL provide enough of a cushion to let Yahoo! grow in banner advertising?

Microsoft's Ballmer may not give up this fight easily. He knows his rival is Google. Microsoft made a bid for DoubleClick only to watch Google scoop up the company instead. The loss still rankles in Redmond.

Yet if negotiations become protracted and ugly, Yahoo! will lose talent, Wall Street will punish Yahoo! and Microsoft, and more pink slips will follow. The only winner in this scenario, again, will be Google.

--Wendy Tanaka contributed to this report

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Google Plays The Anti-Competitive Card

Burlingame -Since about late December, more people have been searching on Google for "Steve Ballmer" than they have for "Eric Schmidt."

Don't count on that continuing.

On Sunday, news began to leak out that Schmidt, Google's chief executive, had put in a call to the doubtlessly miserable Jerry Yang of Yahoo! offering his help in warding off the barbarian at the gate--namely Steve Ballmer of Microsoft.

Google had also issued on Sunday a suitably pious press release from its general counsel: "The openness of the Internet is what made Google--and Yahoo!--possible. ... So Microsoft's hostile bid for Yahoo! raises troubling questions. This is about more than simply a financial transaction, one company taking over another. It's about preserving the underlying principles of the Internet: openness and innovation."

Make no mistake: This isn't about the Internet. It's hardly about Yahoo!. Instead, Yahoo! has become a football in an epic battle between Microsoft and Google--and, between their team captains, Ballmer and Schmidt.

Both Google and Microsoft will try to claim the moral high ground by asserting that their actions will enhance competition in the Internet industry. Like seasoned politicians, no two other high-tech titans have had more experience debating "competitiveness" than this pair.

And both have tasted the sweetness of monopoly profits--and crave more.

First a bit of history: Both Yahoo! and Google were founded during the height of Microsoft's monopoly power--Yahoo in 1994, Google in 1998. Hatred of Microsoft, particularly in Silicon Valley, ran deep during those years. The Redmond software giant commanded fat margins for its operating system and office productivity software.

Microsoft Co-Founder Bill Gates was savvy enough to know even then that Microsoft was most vulnerable to what it didn't expect. He used to like to joke that Microsoft's toughest competitor was probably some tiny start-up no one had ever heard of.

Silicon Valley pundits, by contrast, warned darkly that the days of innovation were over. Microsoft's shadow was enough to frighten entrepreneurs away from whole areas of software. Just look, they charged, at the fact that no company dared try to build an operating system or even a new word processor.

Leading many of those assertions was Scott McNealy at Sun Microsystems, ably supported by his chief technology officer, Eric Schmidt. In April 1997, Schmidt left Sun to become chief executive at Novell, a network software company that had been seriously bruised by its battles with Microsoft.

Much of the personal animosity against Microsoft was directed against Bill Gates. But Microsoft also had a relentlessly aggressive sales force, encouraged to push for the best price and the most favorable contract terms. The tone of that sales force was set by the company's No. 1 salesman, Ballmer.

Schmidt, whose technological specialty was networking, tried unsuccessfully to rekindle Novell's fortunes around its directory services. The effort petered out. Schmidt jumped to Google in 2001.

Had Microsoft truly "chilled" competition? Commercial efforts to build conventional operating systems certainly had poor results. Sun continued to develop its operating system, Solaris. Apart from Apple's operating system, which limped through the mid 1990s, no other significant operating system for PCs emerged. Microsoft squashed enthusiasm for one pen-based operating system called Go. Another, Be, fizzled.

Microsoft then poured its energy into battling Internet browser pioneer, Netscape Communications, ultimately to the detriment of both. Netscape closed up shop and sold the remnants to AOL. Microsoft wound up tied up in antitrust litigation and penalties that continue still.

Outside the areas that Microsoft dominated, innovation flourished.

Gates was ultimately right: His company overlooked the importance of the emergence of the open source (not-for-profit) operating system, Linux. Palm Computing came out with an operating system for handhelds--leaving Microsoft to scramble in its dust to develop its own mobile operating system. And most critically, even after Gates announced that Microsoft was set on understanding the Internet, the packaged software company couldn't spot the need for search engines for sifting through all the data--leaving a big opening for what became Google.

Thank heavens none of those companies thought it would be a good idea to simply build another PC operating system.

Now the tables are oddly reversed: Google commands 75% of search-ad revenues worldwide. It carried out more than 65% of all the Internet searches done in the U.S. during the first four weeks of January, according to market research firm Hitwise. Combining Yahoo! Search and MSN Search would amount to 28%.

Both Microsoft and Google, as well as other industry titans, have flirted with Yahoo! for years. Yahoo! turned out to be its own most devastating competitor: It tried to doll itself up as a Hollywood company. It was slow to build an effective back-end system to monetize advertising. Yahoo! drifted.

Among the deals that have been considered in the past: breaking Yahoo! into chunks, including selling its search advertising business to Google.

That move would leave Microsoft even further out of the online ad business.

Ballmer--the salesman and long-time basketball fanatic--pulled the best lever he saw by offering a sizable premium over Yahoo's! current--and dwindling--share price. Expect to hear him bang the table for a fast decision from the company's board.

Schmidt, who knows Ballmer and Washington, D.C., better than any other high-tech executive, will play a different hand. To buy time, he has set his general counsel beating out the familiar rhythm of "anti-competitive" charges. He will try to round up allies. They will white board a dozen ways to slice and dice Yahoo! to keep it out of Microsoft's hands. Just as Microsoft dragged Google through anti-competitive hearings in Washington, D.C., over the search engine's proposed acquisition of ad company DoubleClick, so, too, will Google call in all its favors and demand that the antitrust busters scrutinize this deal. Schmidt's Washington ties run deep: He currently sits on Apple's board alongside former Vice President Gore.

Both Schmidt and Ballmer know it's easier to delay a multibillion-dollar deal than it is to speed it up. Expect to see this contest go into overtime.

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